Insurance Act 2015: the issues the market is grappling with

There have been a number of issues circulating the market since the Insurance Act 2015 (the "Act") came into force. 

In particular:

• The scope of the new duty of fair presentation – whose knowledge is relevant and what is meant by "reasonable search"? Should agreements be put in place as to what these entail? Should sign-off be sought from insurers that a fair presentation has been made?
• The market's response to the Act by way of wordings – what has been generated and how effective are they?
• What is considered deliberate or reckless; is it something less than fraud?
• How are proportionate remedies applied?
• What is a reasonable time and when are sums "due" for the purposes of a claim for damages for late payment? Are there particular issues that may arise on large structured programmes?

We are yet to see the first case decided under the Act and, until we do, there is a lot of speculation as to how the Act will be interpreted. At a Clyde & Co Financial Institutions and D&O conference, we held a panel discussion between legal, broker and insurer experts and their views on these issues are incorporated in this briefing. We also examine some other issues that we have encountered since the Act came into force.

This briefing should be read in conjunction with our comprehensive guide to the Act: Insurance Act 2015 – Shaking up a century of insurance law.

Fair presentation

One of the main changes brought about by the Act is that an insured must now give a "fair presentation" of the risk; it must disclose all material circumstances it knows or ought to know or give enough information to put a prudent insurer on notice to make further enquiries.

Whose knowledge?

For a corporate insured, "knowledge" is determined by what the insured's senior management, or those responsible for the insured's insurance, knows. The scope of the definition of "senior management" is one of the most frequent queries that brokers receive.

Despite the intention being to restrict actual knowledge to board level, arguably the wording is considerably broader. Section 4(8)(c) defines "senior management" as meaning "those individuals who play significant roles in the making of decisions about how the insured's activities are to be managed or organised." In practice, this presents a number of difficulties, especially for large, global organisations. For example:

• Do senior managers in such organisations have the requisite knowledge of the day-to-day business?
• Who are the senior managers of organisations split into numerous subsidiaries?
• Will knowledge, held by those who are not considered senior management, but who perform a managerial role, be imputed?

The Act further extends knowledge to those responsible for arranging the insurance. Brokers are concerned that this is fusing the division between the insured and the broker, making the broker responsible for all the insured's knowledge. This is a significant expansion and could lead to more claims against brokers if the insurance fails.

What is a reasonable search?

The insured will be deemed to know what “should reasonably have been revealed by a reasonable search”; a potentially onerous requirement. For example, if a company has over 5,000 employees across numerous countries/subsidiaries, how does it conduct a reasonable search? Does the insured have an obligation to make clear which entities have responded positively? There is likely to be no duty on the board to seek information of a dormant company but the board is unlikely to be able to defend the search as reasonable if it did not go to the board of an active company for information.

Thus far, these questions have gone unanswered. No general definition of "reasonable search" within the market has emerged as its scope depends on the size, nature and complexity of the business. Whilst the Law Commission envisaged an increase in the flow of information between insurers and insureds to resolve these difficult questions, in practice, our market panellists noted that there is simply not enough time.

Wordings / agreements

In response to the Act, the market has been flooded with bespoke wordings, perhaps to contract out of certain provisions (in part or whole) or to ensure that the Act's provisions are incorporated regardless of the policy's choice of law clause.

Some of these wordings are likely to be more successful than others. Our panellists warned against paraphrasing the Act's provisions in policies as there is a risk that, if examined, the courts may assume that something other than the position in the Act was intended. If the parties wish their policies to follow the Act, then nothing at all should be put into the policy itself and the Act will prevail.

However, there are many situations where the parties may wish to better define some of the provisions of the Act, such as (i) the scope of a reasonable search; (ii) whose knowledge constitutes that of the corporate; (iii) the application of remedies; and (iv) amending/incorporating pre-Act concessions regarding remedies for misrepresentation/non-disclosure where the terms are generous to the insured.

The efficacy of such clauses is up for debate, if they can be agreed in the first place.

Insureds/brokers across many business lines have been keen to agree with the underwriter what is reasonable/that a fair presentation has been made. Our market panellists commented that insurers have generally been reluctant to do so, wary of either waiving the insured’s duty of fair presentation or of too readily expanding the insured’s duty of enquiry, which could be regarded as contracting out of the Act (in which case the transparency requirements must be met). Some primary layer insurers have inserted such clauses if the insured has demonstrated a clear, logical and comprehensive approach to the disclosure process and has presented the information in a concise and accessible manner. Excess insurers are unlikely agree to such clauses due to their relationship relative to the insured.

Many insureds have sought "sign-off" from insurers that they have made a fair presentation of the risk/conducted a reasonable search. Such agreements are untested and if a dispute arises, insurers may challenge the "sign-off" and contend that they agreed that it was a fair presentation based only on the information presented to them.

Deliberate or reckless breach of the duty of fair presentation

Where there has been a deliberate or reckless breach of the duty of fair presentation, the policy is avoided without return of premium. Counsel on the panel noted that there is a belief in the market that "deliberate or reckless" is something less than fraud¹, when in fact the conduct complained of is the same, but the standard of proof is lower. In other words, fraudulent conduct is deliberate or reckless conduct and vice versa². However, unlike pleading fraud in a criminal context, where it has to be proven beyond reasonable doubt, insurers need only prove it on the balance of probabilities.

In practice, the point is fairly academic and unlikely to arise frequently.

Application of proportionate remedies

Evidencing what new term insurers would have included, had it had a fair presentation, may be difficult. A standard exclusion following underwriting guidelines is fairly straightforward. However, bespoke exclusions will need to be scrutinised and evidence given to demonstrate why it would have been imposed.

Our broker panellist stated that some insurers are inserting a clause into policies, providing for additional premium to be paid in the event of non-disclosure if, had a fair presentation been made, the insurer would have charged a higher premium. The insurer can, at its sole discretion, elect to charge the additional premium or scale down the claim. If the former, the insurer cannot scale down any subsequent claims, having already received a remedy. This clause may be seen as contracting out of the Act so the transparency requirements must be met.

Clyde & Co has fielded many requests about the application of proportionate remedies, particularly in layered programmes. With regard to when the loss attaches to the excess layers, our view is that it triggers at its original attachment point but the insured will, in effect, have a larger retention if a proportionate remedy has been applied. For example:

• The claim is for £3m
• The primary layer is £2m
• The excess layer is £1m xs £2m
• A 25% proportionate remedy has been applied to the primary layer

In this example, the attachment point for the excess layer will remain £2m and any obligation to pay does not arise until the claim reaches that point. But as a proportionate remedy has been applied to the primary layer, the insured will have to bear its agreed deductible as well as the 25% reduction. We consider this to be a logical approach on the basis that the insured should not be benefitting from its non-disclosure by having the excess layer collect the shortfall.

As it is not expressly dealt with in the Act, excess layers could potentially argue that the layer has not been triggered (i.e. where the claim is substantial enough to trigger the excess), but the primary has not been exhausted because only a partial payment has been made (i.e. no assumption that the insured bears the shortfall). However, we think this argument is unlikely to succeed.

Damages for late payment

Section 13A of the Act implies a term into the insurance contract that an insurer must pay sums due in respect of a claim within a "reasonable time". If an insurer breaches this, the insured will be able to claim damages in addition to the right to be indemnified under the policy and interest. Our legal panellists considered that the courts will interpret "reasonable time" fairly generously, linking it to the size and complexity of the claim.

In large programmes:

• If there is a leader clause, the subscription market can expect to be bound by the actions of the leader in the event that it has unreasonably delayed payment.
• In facultative reinsurance, if there is a claims control clause then the reinsurer has control over the claim. If the insurer delays payment to the insured and so breaches the implied term, it would need to seek damages from the reinsurer. If reinsurers unreasonably refuse to give their consent to a settlement (or delay in doing so), thereby causing the insurer to incur liability under Section 13A, this does not put them in breach of the same implied term in the reinsurance contract because their own liability to pay has not been triggered. Currently, common law only recognises that the reinsurer must not act irrationally (i.e. take into account irrelevant external considerations) in reaching its decision. If the insurer heads off a late payment claim by settling without the reinsurer’s permission, and the claims control clause is a condition precedent, then the reinsurer probably has a complete defence.

The wording of the late payment provisions is in relation to any sums "due". In liability insurance, there is no duty to indemnify until after the claim is settled or liability is proven; until such time, there are no sums "due." Regarding defence costs, normally the advancement of such is subject to the insurer's approval, so are these sums "due"? Time will tell.

Conclusion

There are, of course, other issues that may arise (notably, the application of Section 11 and the potential for dispute as to which terms fall within it). Our report on the Act explores many of these issues and we will continue to monitor and report on developments in this area.

¹Possibly as a result of the Law Commission's paper on Insurance Contract Law Reform which stated "In IP1 we described dishonest disclosures and misrepresentations as “fraudulent”. However, many insurers associated that term with criminal standards of proof, and thought that they would only very rarely be in a position to prove that an insured had acted fraudulently in preparing its presentation. It is not our intention that the insurer’s task of proving that a breach of the duty of fair presentation was made deliberately or recklessly should be unduly onerous, or require an exceptionally high standard of proof. In CP3 we proposed that dishonest breaches should be referred to as “deliberate or reckless”."

²Following Derry v Peek (1889) LR 14 App Cas 337 where Lord Herschell defined fraudulent misrepresentation as a statement which is made either: (i) knowing it to be false, (ii) without belief in its truth, or (iii) recklessly, careless as to whether it is true or false.